While some jurisdictions are exploring standalone—and legally dubious—taxes on digital advertising, D.C. Council Chair Phil Mendelson (D) has a more down-to-earth proposal: why not just include advertising in the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. base?
The obvious upside is that it doesn’t immediately raise any legal red flags and it takes advantage of a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. that already exists and with which the District of Columbia and other jurisdictions already have significant experience. But it turns out there are good reasons why advertising is almost always excluded from the sales tax, reasons which go both to core principles of taxation and practicalities about who could be taxed.
With a D.C. sales tax on advertising, if a Virginia company placed ads in D.C. markets, the transaction would not be subject to the D.C. sales tax on advertising, but if a D.C.-based company placed ads in Virginia, it would. How can that be?
The District’s sales tax, like most, is destination-sourced, meaning that a transaction is subject to tax in the jurisdiction where the good or service is received, not the one from which it came. This is relatively easy with the sale of tangible goods but trickier with services, where D.C., again like most of its peers, sources the service to where it is used or its benefit is received.
In advertising, the benefit is to the company placing the ads—which, after all, hopes to profit (or otherwise gain) from the publicity. Where the advertising network is based or where the ads are served is immaterial; the benefit is received where the company is located. Including advertising in the sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , therefore, potentially taxes D.C.-based companies on all their worldwide advertising, while exempting other businesses from advertising that actually targets D.C. residents.
Because the D.C. Code says little about sourcing rules, the details are handled by regulation, and taxing advertising would create considerable complexity, while yielding some curious results. A large retail chain with locations in the District likely could not be taxed on advertising purchases, but a smaller regional chain based in the District could. With a franchised chain, if local franchisees purchased advertising, the transaction would be taxable, but if they benefited from D.C. advertising by the national brand, or by franchise portfolios based elsewhere, the transaction would likely be out of reach.
Fundamentally, sales taxes are not designed to tax intermediate transactions like advertising, and both their rationale and their fairness are called into question when they do. Advertising is a business input, whereas sales taxes are designed to fall on final transactions. Taxing inputs results in what is known as tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. , where the sales tax is embedded in the final price of the good or service multiple times over. Consumers should only pay the sales tax on the actual purchase price of a product, without being asked to cover embedded sales taxes as well, which can lead to considerably more than 100 percent of the value of a product being subject to sales tax.
The sales tax is intended as a tax on final consumption. When a company purchases advertising, it does not do so because its executives enjoy “consuming” advertising; it does so because they want to sell a product, which itself will be (or at least usually should be) subject to sales tax.
Sales tax sourcing rules do not work nearly as well when the tax is extended to intermediate transactions, because that’s not what sales taxes are for. Destination-based sales taxes do not have much of an impact on a business’s location decisions, because the tax is borne at the purchaser’s location, not that of the business. But when the business itself pays sales tax on its inputs (including advertising), the cost of doing business in that jurisdiction rises.
Mayor Muriel Bowser (D) has emphasized that the budget is balanced despite the COVID-19 pandemic and is discouraging the Council from adopting any new taxes at this time. Chairman Mendelson, while favoring this and several other smaller tax increases, has indicated that it is not the time to consider larger tax changes. Councilmember Trayon White (D) intends to offer an amendment which would lower the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. threshold, potentially making neighboring Maryland (higher threshold) and Virginia (no estate tax) relatively more attractive. Councilmember Charles Allen (D) is proposing increasing the top marginal individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate to 8.95 percent, which not only puts the District at a greater regional disadvantage just as remote work options are becoming increasingly viable, but would also represent a retreat from a compromise reached in 2014 in adopting a package of tax reforms.
Mayor Bowser and Chairman Mendelson wish to defer those considerations, which seems prudent. That leaves the advertising tax proposal and a few others potentially still on the table. Local lawmakers should think long and hard before extending the sales tax to advertising, given how arbitrary it would be in practice.
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